NY futures moved sideways this week, as December edged up just 7 point to close at 73.04 cents.

The market seems to be settling into a new trading range, which is about 10 cents higher than the one it occupied for nearly two years prior to the breakout. The December contract has now closed the last 12 sessions in a relatively tight band of just 199 points, between 72.29 and 74.28 cents/lb.

Underlying support appears solid due to pent up mill demand and the 7.17 million bales in unfixed on-call sales, whereas resistance near 75 cents has so far been tough to overcome, as the downstream sector seems reluctant to adjust to these higher prices.

Implied volatility, which gauges the market’s fear and nervousness, has further dropped this week and measured just 22.8% today for December options, down another 2.8% from last Thursday.

However, it would be complacent to conclude that the market has already put in a top, for a variety of reasons. First of all, futures open interest remains at a record level for this date at 23.74 million bales, which is about 6.0 million more than a year ago and 1.66 million bales above the previous high mark set in 2008.

This means that the many spec longs have not given up on cotton just yet! According to the latest CFTC report as of July 19 speculators were 9.3 million bales net long, up 1.3 million bales from the week before, and they still have room to grow this position by a million bales or two before it reaches record levels.

Then there is the surprisingly strong Chinese market, which keeps selling its Reserve cotton at a furious pace at higher and higher prices, indicating that Chinese demand may still be underestimated even after the USDA has raised its number by 1.5 million bales a couple of weeks ago. The average auction price is currently at around 102 cents, while the CC-index has risen to nearly 105 cents/lb!

China has auctioned off around 1.6 million tons or 7.3 million statistical bales so far and there are rumors that auctions might continue beyond the scheduled 2.0 million tons. Since Chinese raw cotton imports are already at 0.86 million tons with one month remaining in the marketing year, this suggests that the production gap might be bigger than the 2.94 million tons the USDA currently estimates.

Rumors of additional auction sales in China have apparently contributed to the drop in ICE futures overnight, which doesn’t make sense to us, since stronger auction sales are a sign of better demand and they don’t necessarily reduce raw cotton imports to China, since the TRQ quota will still be used, especially at the prevailing price difference between China and the US.

Chinese yarn imports have also remained relatively strong at 1.74 million tons for the first eleven months and are only about 7 percent off last year’s pace, some of which may be attributed to the lack of suitable offers from the Indian Subcontinent due to the scarcity in India and Pakistan.

Another potentially bullish factor is the weather, as both India’s Gujarat and West Texas are in need of more rain. While there has been some improvement in both areas this week, Gujarat’s Saurashtra and Kutch regions are still deficient and in West Texas only a few stations have received a small amount of rain this week, although there is another chance for thunderstorms tonight.

US export sales of Upland and Pima cotton for the week that ended on June 21 amounted to a strong 277,600 running bales, with 15 markets buying and 23 markets receiving shipments of 192,500 running bales. Of note is that China bought 71,500 running bales and Pakistan booked 57,400 running bales!

Total commitments for the current marketing year, with 10 days to go in the count, are now at 9.9 million statistical bales, whereof 8.9 million bales have been exported. Sales for 2016/17 have so far reached 2.6 million statistical bales.

Like in the previous week a lot of these new sales were made ‘on-call’, as total unfixed on-call sales increased by 128,100 bales to 7.17 million bales, despite the fact that on-call sales for December dropped by 102,100 bales net as some mills obviously decided to fix.

So where do we go from here? A look at the chart shows that the market has been ‘flagging’ sideways in a tight range for the last two weeks. More often than not flag patterns are resolved in the direction of the prevailing trend, which is up.

A lot will depend on the weather over the coming days and weeks! If the two trouble spots receive beneficial rainfall, then the market is likely to ease off into support, which should be near the 70 cents level or maybe a cent or two lower if there is sizable spec long liquidation.

However, as pointed out above, the market doesn’t need much of an excuse to resume its uptrend and continued lack of rain in Gujarat and/or Texas might do the trick! While speculators have set the ball rolling, the second phase of a bull market is often fueled by commercial short covering. For now we continue to give the market the benefit of doubt and stick to our 68-76 trading range, but we shall keep an eye on the weather!